Euro-Zone Economy Humming, Unlike U.S.

By AP

Thursday, 10 May 2007 | 5:08 AM ETThe Associated Press

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The euro is rising, unemployment is falling and the economy of the 13 EU nations that use the common currency is keeping pace with last year -- in contrast to the U.S., where growth is slowing and the dollar keeps falling.

As Europe's economy has chugged along, a string of rate increases by the European Central Bank has helped keep inflation in check. But even at the risk of sending the euro to uncomfortable highs and hurting exports, the ECB is expected to signal this week that it plans to raise rates again, to 4%.

The EU said Monday it expects growth in the euro zone, which accounts for more than 15% of the world's gross domestic product, to charge forward this year and next. The ranks of the unemployed are expected to thin to the lowest levels in 15 years, it said.

The euro zone is expected to expand by 2.6% through this year -- up from an initial forecast of 2.4% -- as investment and household spending rises. That's slightly lower than last year's rate of 2.7%, but solidly on track as the zone stays abreast of a predicted U.S. slowdown and expands trade with Asia and other regions of the world.

The U.S., meanwhile, is seeing a housing slump, rising energy prices and sluggish overall economic activity. Last week, government data showed that jobseekers had a harder time finding work last month as the economy cooled and wary employers added the fewest positions in two and a half years.

The world's largest economy also logged its worst economic growth in four years in the opening quarter of 2007, crawling at a 1.3% pace. That has raised new questions about whether troubles in the U.S. housing market will spread and throw the economy into a tailspin before the year is out. The Federal Reserve is expected to leave a key interest rate at 5.25% when it meets next Wednesday.

While the Fed raised rates 17 times from June 2004 before pausing last year at 5.25%, the ECB held steady at 2% from June 2003 until it raised rates seven times starting in December 2005 to the current 3.75%.

The Bank of England also meets Thursday and is expected to increase its rate from 5.25% to 5.5%.

Most analysts believe the next ECB increase will not come Thursday, when the bank meets in Dublin, Ireland. They expect ECB President Jean-Claude Trichet to send a signal that at least one more quarter-point increase -- to 4% -- will come in June, a pre-emptive strike against inflation.

EU economists expect wages to increase but to stay moderate over the next two years, keeping inflation close to 2% -- adhering to the European Central Bank guideline and undermining one of its reasons to raise interest rates.

But Trichet seemed to give a preview at the Bank for International Settlements meeting this week, when he said a central bank should not rest in fighting inflation.

"We are in an episode of the global economy which is extremely encouraging, but there is no time for complacency, and central banks should never be complacent," he said.

"Part of the success of the global economy -- and we trust a substantial part -- is due to the fact that we could preserve price stability and the continuing preservation of price stability is certainly a permanent condition for having a continuous and sustainable global growth."

Economists and analysts will be listening for any comments by Trichet after the governing council meets to hear what he has to say about inflationary threats and the new outlook for growth in the euro zone.

One area of concern had been wage agreements, especially in Germany, the euro zone's largest economy. At last month's meeting, Trichet warned that excessive increases in wages, along with creeping consumer price rises, could spur inflation.

Last week, the German union IG Metall reached an agreement with employers for a 5.8% increase in wages over 19 months. It had been demanding a 6.5% rise.

EU economists expect wages to increase but to stay moderate over the next two years, keeping inflation close to 2%. But prices will edge higher in 2008, the EU said.

Gilles Moec, an analyst with Bank of America, said he expected the ECB to signal on Thursday that it planned to raise rates by a quarter of a percentage point in June by using the "strong vigilance" phrase that has augured increases in the past.

"The ECB seems inclined to reach a roughly neutral 4% in June," said Holger Schmieding, Bank of America's chief economist for Europe. "If the euro-zone economy gains further momentum in late 2007 and early 2008 ... the ECB will probably raise rates further to 4.5% by mid-2008."